With global markets unravelling on account of the debt crisis, investors across the world are in a tizzy and Indian investors are no different. With Sensex losing 18% so far this year, investors are confused whether it’s the right time to put money in equities. Add to that the rising policy rates—the Reserve Bank of India (RBI) has raised the key interest rate (repo rate or the rate at which banks borrow from RBI) 11 times since March 2010. In fact, on the day you read this, it may raise the policy rate once more. Gold has returned 25% in the past five years; so far this year it has risen by 28%. Is there more steam left in it?
Building a sustainable portfolio across asset classes is always a challenge in times of uncertainty. Mint brings together a panel of eight experts across the financial industry to bring clarity to the crisis in front of us, to cut through the jargon and to suggest a strategy for the common man to build sustainable portfolios.
Abhay Aima, country head (equity and private banking), HDFC Bank Ltd; Nilesh Shah, managing director and chief executive officer, Envision Capital Ltd; Prashant Jain, chief investment officer, HDFC Asset Management Co. Ltd; Rakesh Jhunjhunwala, chief executive officer, Rare Enterprises; Ridham Desai, managing director and head (research), Morgan Stanley, India; Ritwick Ghoshal, senior vice-president and head (wealth management and liabilities), HSBC India; S. Naren, chief investment officer (equity), ICICI Prudential Asset Management Co. Ltd; and Vetri Subramaniam, chief investment officer (equity), Religare Asset Management Co. Ltd debated at the Mint Money conclave on Wealth Management: Building Sustainable Portfolios, in Mumbai on Tuesday.
Mint’s deputy managing editor Tamal Bandyopadhyay moderated the discussion. Edited excerpts:
Bandyopadhyay: We are in uncertain times; in four years, the stock market hasn’t moved anywhere. Debt investments have given good returns, but inflation at 9%-plus for the last 13 months is eating away your returns. Gold is the flavour of the season. Real estate prices have reached such a level that very few brave hearts are venturing into it. After the 2008 financial crisis, certain standard assumptions about risk management, wealth management and where to put your money have gone out the window. Correct me if I am wrong, in India, fund managers and investors, even though we are in a new zone, peddle the old truth. If you are in your 20s, invest more in equity than debt, if you are in the 50s, do the reverse and stay invested in equities for the long term. How long is long term? Nikkie is nowhere near the level it reached in the 1990s, it’s one-third of that now. So, is a loss decade staring at us?
Power talk: Panellists at the Mint Money conclave on Wealth Management: Building Sustainable Portfolios, in Mumbai on Wednesday. Photograph by Hemant Mishra/Mint
Aima: The beauty about the markets is, depending whether you are bull or bear you can take any time line and from there draw a chart and say if you have done exceedingly well or very badly. The fact is it is an asset class that historically has given you close to 20%. You can take the peak of 2008 and chart it or go back 10 years. Look at Dow Jones and paint a bullish scenario. I think the equity market in India is a great place. You should look at remaining invested, not as a trading class, but as an asset.
Ghoshal: As a wealth manager, I will not talk about equity per se, but in terms of all asset classes. Surprisingly, large inflows in equity funds have happened in the last two to three months. Even in debt funds, as well as gold, there are opportunities. But holistically, we have rebalanced portfolios, which were heavily skewed towards equity. We are looking towards debt and gold, and alternative investments like structured products, fixed maturity plans and so on.
Naren: I think equities will always remain a volatile asset class. We, as part of the mutual fund (MF) industry, recommend asset allocation and products like systematic investment plans (SIP) and systematic transfer plans. We have seen good returns; if you go back one year there was so much enthusiasm, markets were at 20,000 levels and everyone was thinking they will go up further.
The problem is that volatility has increased because of global events. As Carmen M. Reinhart and Kenneth S. Rogoff pointed out, once you have a banking crisis, you will have a period of volatility, we are in that period right now. How do you handle a period like this? Use asset allocation and SIP. As long as you do it, you will make returns.
Subramaniam: There are long cycles in the equity markets and returns may not necessarily be as high as we are accustomed to. Therefore, when we make statements such as equity is for the long term, it’s important to keep in mind that long term could be 5-20 years. If we look at the US, there have been 17 to 20 cycles when markets have done well, and other cycles when markets have done poorly.
In the context of equities, SIP is a fantastic way to even out volatility, but you can’t lose sight of asset allocation. There is clearly a support which equity investors need, in the sense that they need to be cognizant to market valuation.
Shah: It’s unfortunate that when we look at equities as an asset class, the return expectation is the highest, but the time frame is the shortest. When we look at other asset classes such as real estate, private equity, bonds, we look at 5-10 years. But when we look at equity, we look at shorter time frames. If we look at returns over similar time horizons with debt instruments, equities have delivered 17%-plus returns over 10 years after accounting for dividends and its tax-free status. I don’t think it’s been a lost decade. Over a 5-10 years’ horizon, I still think its among the best performing asset classes.
Jain: Equities are a very simple asset class. In the long run, it has returned as much as nominal business growth. Businesses in India have grown at 15%-plus compounded annual growth rate (CAGR) and that’s why the Sensex has delivered 18-19% CAGR. That’s a beautiful return over 30-40 years. I’m quite optimistic about economic growth prospects of India. Once in a while every few years due to high fiscal deficit or other issues such as high interest rates, we see a slight moderation in growth rates, but they will pick up again.
The problem with equities is that people focus more on the news flow and less on the valuations. If you focus more on the valuations and less on the news flow, you can make above average returns. You will get great valuations only when the news flow is bad. If you see the last 10-15 years whenever the news flow is bad, price-earnings (P-E) multiples have dropped. Investments made at that time, not over three months, but over three-five years, have given returns significantly above 17% CAGR. I feel this is a similar opportunity.
Desai: As Prashant said, if I can summarize, the point of maximum uncertainty is also equal to the point of maximum return. Right now the world looks very uncertain and grim, the news flow is terrible. That’s really the time you want to buy equity, not a time like January 2008, when everything looked good—that’s the time when you don’t want to buy.
If you have a three-five years’ view, you should do quite well in equities. Shorter time frame is very hard to forecast, the next three months is impossible to forecast and that is the case at any point in time. My bet is equities will probably be the best asset class in the next 5-10 years and this is a good time to buy. Bear in mind there could be downside risk and you can keep buying when there is a downside.
Jhunjhunwala: Has any country in this stage of economic growth and this kind of demographic profile and size ever lost out on economic growth? If earnings growth is going to be a function of nominal gross domestic product (GDP) growth for the next decade, India will show a 15-18% earnings growth. This year Indians will save $700 billion; even if 5% of that comes to the equity market, it’ll be great. Indians have imported gold in the last five years, equal to the size of the Indian MF industry. Despite economic growth you have vast under-exposure in Indian equity.
How can we even compare ourselves with Japan of 1989? Do we have that kind of a bubble? Do we have that kind of a world investment in our industries? Do we have that kind of leverage? If you look at the movement of the index, it has always taken time to consolidate after a big spurt. If we look at valuations, we are overvalued today. Our average valuations have been 14-15 times. I think a Japan-like boom will come to India in the next decade and we are not going to peak before 25-30 times. So, at 15-17% earnings growth in the next 10 years and 60-80% rise in the P-Es, the kind of index level that can be projected, is mind-boggling. I am sure of one thing: given India’s growth prospects and underexposure of Indian to equities, it will be empirical for foreigners to invest in emerging markets. I think the best decade is still ahead of us.
Bandyopadhyay: Are Indian markets in a better position than the European and American markets? Is there an opportunity for India in the slowdown in Europe and the US?
Naren: Last year, inflation was a big problem in countries like India, Brazil and China; these countries did badly last year in terms of performance. Basically, growth came back to the western world but it didn’t last. Now we are back to a situation where we are worried about growth in the entire western world and our own worries on inflation are lower. This puts countries like India in a better position for fresh investments.
Also, interest rates in most of the Western world have been brought down close to zero. But India has such a high interest rate that there is a potential to give a big boost to the economy by bringing them down. That is going to be the big difference between countries like India and the western world. There they are facing a crisis, they have a demographic crisis and they are facing a crisis where monetary stimulus is not possible. In India the situation is opposite.
That’s why we look at stocks in a different way from the rest of the world. Because the West is in a bad shape and there is no exuberance in India, falling markets offer opportunities to buy good stocks if we get money from all of you for the long term.
Bandyopadhyay: Are you saying that inflation is coming off and it’s time to cut rates?
Naren: You’ve had a good monsoon, earlier a good monsoon meant that the entire market would focus on it. Now despite, one of the best monsoons in recent times, people have forgotten about it. Today people are only focusing on the negative and whenever that happens, it is a good opportunity to put money in equity as the market falls in a staggered fashion. We never know where the market will bottom out. So as the market falls, people can put money and they will make money.
Ghoshal: As a bank we are looking at all the asset classes. We are looking at international equities through the feeder fund route. We want our clients to look at other opportunities across the world such as commodities, global agri-business and other themes over the next three-four months.
Bandyopadhyay: Abhay, are you also seeing interest among your clients to diversify into overseas markets like Brazil?
Aima: From an asset allocation point of view, if you want to diversify, one can probably recommend it. Remember the western world is looking at 1-2% GDP growth. Commodity and crude prices are likely to come down. About 80% of India’s GDP comes from the domestic economy and 20% from exports. I think the rest of the world will slow down over the next 10 years. Hence, commodities and crude prices will fall. In that case, 80% of India’s GDP will get a boost.
I would not look at advising investors to look overseas through feeder funds or otherwise. I expect the rupee to appreciate in the next three-five years. With currency, taxation and growth in your favour it is difficult to look overseas for investments.
Desai: India has to invest in the infrastructure sector in the next five-seven years. We will be big consumers of commodities, like China was in the last 10 years. If the Western world were to go through a prolonged slowdown, which I think is possible over the next five-seven years, commodity prices will get capped. This is good for India as the cost of setting up infrastructure will be lowered and provide tailwind to our economic growth.
If you look at it from the stock market perspective, it is not odd for India to trade at 20 times when the rest of the world trades at 10 times. That’s exactly what happened in the 90s when the US equity markets consistently traded over 20 times earnings and the emerging markets like India, rest of Asia and Latin America went through a banking crisis and external crisis and they had to restructure.
I think it’s a perfectly possible scenario. This is turning out to be fairly positive for India, notwithstanding the 20-30 basis points of growth we may lose as a result of exports to the West. On the matter of exports, I see the emerging world becoming a larger part of India’s exports. So that won’t be such a problem.
The only risk factor in the near term is capital flows. If this morphs into a financial crisis of sorts as in 2008, access to capital may get difficult.
Jhunjhunwala: Is there going be a shock or is there going be a recession? Is there going to be a crisis in the system or a crisis of the system? I don’t rule out the crisis of the system in the Western world, especially in Europe. And so if there is crisis of the system, I think, India will be badly hit, at least for a year or two. Because then we are going into unknown territory, where the capitalists world has never gone. When you talk of countries like Italy and Greece defaulting, and the US unable to borrow, anything can happen there.
But I think better sense will prevail and it will be a crisis in the system and not of the system. If there is crisis in the system, it will attract capital in India. The lowering of commodity prices will be the biggest advantage to India. And the low cost of capital worldwide will be transmitted to India.
Subramaniam: Comparing a developed world with India is a bit like comparing a middle-aged balding man trying to figure out how to grow his hair again to a teenager whose hair is overgrown and all he needs is a hair cut. The central bank, in some sense, is delivering a haircut, the market is delivering a haircut with resetting expectations.
But I think this is where the opportunity lies. I don’t think we are completely cut off from what is happening in the rest of the world. There are some dependencies on the trade account, capital account, so growth will get affected to some level. But just look how far we have come, in the mid-90s, the growth rate of 5% and 6% was aspirational. But there is a disappointment with 6-7% growth rate. If you look at the rest of the world, a growth rate of 7% is also very good.
Shah: I don’t think, we can say that we will always remain decoupled. When the Western world slows down, it will affect us. I think our ability to bounce back in terms of growth potential is significantly higher.
Jain: Our economy is quite insulated from outside events because exports as a percentage of GDP are small and our share of global exports is minuscule. The information technology industry’s exports in the last 10 years has grown at 25-30% CAGR; 70% of that has come from market share growth and that is what will happen with manufactured exports.
If you look at five-year growth of the Indian economy and the world economy, there is no correlation, as also in the case of long-term equity returns between Sensex and foreign stock market indices like Dow and FTSE. Our markets correct sharply mainly because of sentiments. However, such dips are the best times to invest in a staggered manner over time. Whether it was September 2001 or the crisis of 2008, such times are the best times and in my mind this time will not be different. In fact, the crisis may hasten the peaking out of interest rates and that may be a significant trigger for equity markets, going ahead.
Bandyopadhyay: Speaking of sustainable investment across asset classes, what basket of assets do you recommend?
Shah: I would be most skewed towards equity as an asset class. Rest of it, you could still hold as cash, liquid funds. Fixed-return instruments are illiquid and have lock-ins. It would be better to be in instruments like equity or liquid funds, where you can withdraw money at 24 hours’ notice.
Subramaniam: Given the current valuations, equity has to be an asset class for the next five years or more. Additionally, invest in debt, property and gold based on your needs. Use gold to hedge your portfolio; it is not really a part of your core asset allocation that aims to create wealth for you over five years. The role of creating wealth has to come from equities.
Naren: Indian equities and debt look interesting. Globally people are moving to assets that offer safety. So go in search of the opposite, you can’t go wrong because the whole world is going away from it. In other parts of the world, interest rates are close to zero; here we are getting 9.5-10% in most debt instruments. So you should invest in equity and debt MFs and to some extent global equity MFs because everywhere in the world, equities have become cheap.
Jain: India should become one of the top five economies of the world in 5-10 years. If you reach there then interest rates in India won’t be high for long. It doesn’t make sense to invest outside India; the Indian debt should deliver returns equal to more risky asset classes outside India.
Choose a mix of Indian equity and debt depending on your risk appetite. Ask yourself a question: how much of your wealth can you put away for the next two-three years and can tolerate some volatility in the interim, put away that much in equities.
Ghoshal: We are looking at alternative investments like structured products, fixed maturity plans, some ideas in private equities for the private banking clients, more specifically, a mix of equity MFs, dynamic asset allocation funds and then short-term debt instruments. Also look at bonds.
Jhunjhunwala: I think for the next 5-10 years, if equity is to give me 18% post-tax returns, I want to know one asset class that will give me the same returns, the same ease of management with the same liquidity. I don’t find any asset class apart from equity. Painting and antiques cannot be big investment classes.
Aima: Given the nature of our market, it is developing and by and large we are single asset investors and asset allocation as a concept is not understood. When you talk about asset allocation, the idea is to be underweight or overweight, it is not a concept of being fully invested or not in one asset class. Over time, wealth managers and advisers reduce allocation based on two factors, valuation and personal risk profile.
Desai: I can’t disagree with equities, which I feel will be among the best going forward. Also, this country is really short of land. We have one-fifth the per capita land that Americans have. So I think land is viable for the next 10 years. Long-term bonds are probably not as attractive. In terms of asset allocation, I would rate equities highest, followed by land and then a bit of long-term bonds.
Bandyopadhyay: Sensex after five years and your favourite sectors?
Aima: Five years is indeed crystal-gazing. I am pretty bullish on GDP growth over the next five years, 6.5-7% at the least. Sensex could grow 15-18% CAGR over the next 5-10 years. The best way to choose sectors is to look at the GDP and its composition. Services sector comprises 56%; you align your portfolio 56% to services. I am extremely bullish on agriculture worldwide and for India too.
Another sector is infrastructure, as things can’t get worse than this, it can only get better. It doesn’t include real estate firms. It includes power. The problem is infrastructure requires a lot of government intervention and given that the election is about two and half years away, politicians will do as much as possible to keep things moving.
Naren: I don’t crystal gaze on markets. I tell people to practice asset allocation genuinely. As far as sectors are concerned, exports will be one of the good sectors to invest in over the next two-three years because you have the advantage of the cost of Chinese imports going up. Mid-caps as a group looks good for the long term and infrastructure is something you should invest when interest rates are reduced as they have suffered most on account of high interest rates.
Jain: I’m glad you asked five years—in equities it is easier to talk about the longer term than short term. In five years, earnings will double, if P-E multiples go near their long-term averages, they could go up 20-50%, my best guess would be that index could more than double in the next five years. In terms of sectors, we are looking for sectors where sentiment is most beaten down and those that are hurt most by interest rate. These are cyclicals and infrastructure. There has been a flight to safety and predictability. Thus, consumer and pharmaceutical company stock prices have increased. From here on, their P-Es may not go up even as earnings will continue increasing.
Desai: From a longer-term perspective, financial services sector stands out. Infrastructure services should do well. But there are challenges. If you select companies carefully, there could be money to be made there. Agriculture is a good theme too. Consumer products are very expensive and experience shows that if you buy expensive stocks regardless of fundamentals you don’t make returns.